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The US Federal Reserve last night announced its decision to initiate a fresh round of quantitative easing. The aim was to inject more money into the system. But not everyone has been so impressed. In fact, Toby Nangle, director of the multi asset and fixed income teams, Baring Asset Management, explains why he thinks the move is “one of the greatest policy mistakes in the Fed’s history”.

Ben Bernanke (Source: Getty Images)

"Last night the Federal Reserve moved to announce that it will embark on a second wave of quantitative easing (QE) in the United States, injecting fresh money into the system by purchasing US$600bn worth of US government bonds over the next eight months.

In our view, this is one of the greatest policy mistakes in the Fed’s history. Certainly, the first round of QE worked: it addressed a huge liquidity problem with a major liquidity solution. In other words, it was the right medicine to the right problem. Two years on, the principal problem in the United States is one of solvency and growth rather than liquidity. Indeed, there is currently a relative abundance of liquidity in the economy, borne out by low yields on corporate bonds and free flowing capital to businesses. Despite this, the economy faces huge headwinds in the form of high unemployment and continued issues with the housing market.

So how will a liquidity solution correct a solvency problem? Clearly, believing they have found a new elixir, the authorities have come to the conclusion that QE will cure all ills. In this regard, we are very sceptical. It appears that the Fed is gambling that the so-called portfolio balance channel effect – pushing money out of government bonds and into other assets – will lift risk asset prices and cause the dollar to fall, thus boosting the US economy and essentially scaring the prudence out of savers. The gamble is that this boosts profits and wages, rather than simply prices which would be counter-productive.

We remain unconvinced and view QE2 as a huge policy error on the part of the Fed. However, over the short-term, we expect recent market trends to continue as investors maintain an appetite for risk. After all, the announcement was roughly in line with market expectations."